I'm the director of Cato's Herbert A. Stiefel Center for Trade Policy Studies, focusing on WTO disputes, regional trade agreements, U.S.-China trade issues, steel and textile trade policies, and antidumping reform. Ikenson has been involved in international trade since 1990. Before joining Cato in 2000, I was director of international trade planning for an international accounting and business advisory firm. Before that, I co-founded the Library of International Trade Resources (LITR), a consulting firm providing interactive information access and international trade consulting. And before that, I was a trade policy and antidumping analyst at a few different international trade law practices in Washington, DC. I am the author of many studies and articles on trade policy and is the coauthor of Antidumping Exposed: The Devilish Details of Unfair Trade Law. I've appeared on The Newshour with Jim Lehrer, CNN, CNBC, Bloomberg TV, MSNBC, ABC News, and NPR. My articles have been published in the Wall Street Journal, the Washington Times, the Detroit News, National Review Online, and elsewhere. I hold a M.A. in economics from George Washington University.

Trade Deficit Oped In The New York Times Is Heavy On Fallacy And Wrong On Economics

The New York Times published an oped yesterday by Jared Bernstein and Dean Baker, which presents a badly misinformed view of trade deficits, budget deficits, and the causes of economic growth. Nearly every paragraph in the piece relies on an assailable premise or discredited assertion. The essence of their argument is that the U.S. trade deficit is to blame for slow U.S. economic growth and that the solution is to reduce that deficit by deliberately crippling imports and promoting exports. Their premise is wrong and their recommendations are even worse.

Bernstein and Baker are from the “leakage” school of thought, which posits that resources spent on imports vanish into the ether without any positive benefits accruing to the U.S. economy. They write: “Running a trade deficit means that income generated in the United States is being spent elsewhere. In that situation, labor demand – jobs to produce imported goods – shifts from here to there.”

That is such an elementary fallacy to commit that only one of two conclusions can be drawn: (1) The authors are not qualified to write about the subject or (2) they are hoping to advance a narrow agenda.

By purchasing more goods and services from foreigners than foreigners purchase from Americans – their argument goes – U.S. factories, farmers, and service providers are deprived of sales, which reduces domestic output, value added (GDP), and employment. But their argument relies on the assumption that the dollars sent to foreigners to purchase imports do not make their way back into the U.S. economy—an assumption that even undergraduate economics students know to be false.

The dollars that go abroad to purchase foreign goods and services (imports) and foreign assets (outward investment) are matched virtually identically by dollars coming back to the United States to purchase U.S. goods and services (exports) and U.S. assets (inward investment). Any trade deficit (net outflow of dollars) is matched by an investment surplus (net inflow of dollars). This process helps explain the absence of an inverse relationship between the trade deficit and jobs and between the trade deficit and domestic output, which is all that anyone needs to observe to appreciate how badly the Bernstein-Baker piece misses the mark.

As the chart below demonstrates, if anything, there is a positive relationship between the trade deficit and GDP. In years when the deficit is rising, GDP is increasing; when the deficit is falling, GDP tends to level off and stagnate. Only in the three most recent years has a growing economy (anemic as it has been) been contemporaneous with a declining trade deficit. But it’s worth noting that import growth was substantial during those years.

The trade deficit equals the excess of imports over exports. Homing in on the relationship between imports and GDP and between imports and jobs, a very clear, strong, positive relationship is evident for nearly the entirety of the period.

As the charts below reveal, in years when imports increase over the previous year, U.S. GDP and employment tend to increase from the previous year. In years when imports show a decline, output and employment also tend to decline. The high incidence of observations in the upper-right and lower-left quadrants in both graphs suggests positive relationships between imports and output. In fact, in only one of the 44 years observed did imports and output move in different directions.

The relationship between imports and jobs is also demonstrated to be positive. In 39 of the 44 years observed, the measurements moved in the same direction.

If the trade deficit reduces economic activity and destroys jobs, why are there positive relationships between these variables?

One important reason is that investment inflow provides capital that supports U.S. economic activity and job creation. Inward investment used to finance the trade deficit comes primarily in the form of foreign purchases of U.S. equities and direct investment in property, plant, and equipment. It also includes purchases of corporate and government debt, the latter of which also underwrites U.S. economic activity, but demonstrably less efficiently than investment in the private sector.

This inward investment produces real wealth and other benefits for American businesses, workers, and consumers. When dollars leave the economy to purchase imports and come back as foreign equity investment in U.S. businesses or foreign indirect investment in factories, research centers, or shopping malls, the U.S. economy enjoys benefits that would never have accrued had those dollars been prevented from going abroad in the first place.

In two recent papers (here and here), I demonstrate how inward FDI produces greater benefits than purely domestic investment does by comparing the performance of “insourcing companies” (foreign companies that invest, employ, design, and produce in the United States) to the U.S. private sector average over 10 years and across 20 different metrics, including: value added, capital expenditures, research and development expenditures, compensation, employee benefits, return on assets, intermediate goods purchases, exports, and taxes paid. Over the course of 10 years, insourcing companies performed better than the U.S. private-sector average on 17 of those 20 metrics, thereby raising average U.S. economic performance.

Even though these insourcing companies represent less than 0.5 percent of all U.S. companies with payrolls, collectively they account for 5.9 percent of private-sector value added; 5.4 percent of all private-sector employment; 13.0 percent of U.S. private-sector employee benefits; 11.7 percent of new private-sector, non-residential capital investment, and; 15.2 percent of private-sector research and development spending. According to the most recent data, they paid 13.8 percent of all corporate taxes; earned 48.7 percent greater revenues from their fixed capital than the private sector average, and; compensated their workers at a premium of 22.0 percent above the U.S. private-sector average.

These findings suggest that running trade deficits may actually be a bonus for the United States since the investment surplus brings cream-of-the-crop foreign companies to U.S. shores, where industry best practices are disseminated, and novel ideas are spawned.

Moreover, contrary to the implications of Bernstein’s and Baker’s piece (and the overt claims of their fellow travellers), the trade deficit is not a running tab that we or our children will have to pay back to foreigners. The only portion of the trade deficit that the American public will have to pay back is that which finances the U.S. government’s debt, which accounts for about one-third of the value of all foreign investment and is not a failing of trade or investment policy, but a consequence of excessive government spending, which Bernstein and Baker contend has not been substantial enough.

By the second half of the op-ed, the authors’ objective becomes apparent. Citing foreign currency manipulation as an important reason why the trade deficit persists, Bernstein and Baker suggest that we could “pass legislation that gave the government the right to treat currency management as a violation of international trading rules, leading to offsetting tariffs.”

First off, it’s a bit fanciful to think the U.S. Congress can unilaterally pass legislation that gives the U.S. government the right to deem a foreign government’s action a violation of “international trading rules.” That “right” would have to come from an international agreement, not a U.S. law. But more substantively, economists across the political, academic, and geographical spectra disagree intensely on how to determine the proper market value of a currency, and thus how to measure currency manipulation. Recall the Schumer-Graham bill, which was introduced in several consecutive Congresses, but never came to pass. It would have imposed a 27.5% duty on all imports from China unless and until the Chinese government allowed the currency to appreciate by an amount deemed sufficient by Congress. You know how that figure – 27.5% – was determined? It was the midpoint of the range of credible estimates of Chinese RMB undervaluation – a range that spanned from 15% to 40%. Why was there such a range? Because economists don’t agree on how to measure the proper market value of a currency (beyond letting all currencies float freely).

Moreover, discerning the impact of currency values on trade flows is much trickier than the old economics textbooks would have you believe. Globalization and cross-border supply chains – particularly relevant to China, which is an export processing economy that imports a substantial portion of the raw materials and intermediate goods it uses to produce or assemble its final goods for export (about 50% of the value of Chinese exports to the United States is Chinese value-added; the rest is imported) – have complicated the relationship between currency value and trade. RMB appreciation has reduced the cost of imported inputs, enabling Chinese producers and assemblers to reduce their prices for export, keeping their exporters competitive and the bilateral trade deficit growing despite the 30 percent real appreciation in the RMB since 2005. I have gone into detail about this issue on several occasions, including here, here, and here.

Another important point in response to the authors’ call for taxes on imports of “currency managers” is that many different factors affect the value of a currency. How should currency manager be defined? Which determinants should constitute intentional interventions designed to secure a trade advantage? Exchange rate intervention? Expansionary monetary policy? The utterances of central bankers that move interest and exchange rates? Presumably, the authors seek a definition so amorphously “gerrymandered” as to excuse U.S. quantitative easing, while ensnaring the virtually identical Japanese variety. If they think expanding the money supply through quantitative easing, while “seeking” to secure a trade advantage residually will nab Japan but not the United States, remember that it is the United States that has the official government policy of doubling exports by the end of 2014.

And finally, why would we be better off taxing imports? They’re pro-cyclical. They’re crucial to U.S. producers (65 percent of all U.S. import value in 2012 was intermediate goods and capital equipment). They increase real incomes through their competitive effects on variety and price.

Most incongruently, the authors suggest that “We could also tax foreign holdings of United States Treasuries, making the usual tactic of currency managers more expensive. And we could institute reciprocity into the process of currency management: If a country wants to buy our Treasuries, we must be able to buy theirs.”

So let’s get this straight. The same guys who are advocating greater borrowing and spending by the U.S. government to “grow the economy” are simultaneously proposing that the interest rates on that borrowing be raised? Somehow they seem to think that the U.S. government is doing its creditors a favor by allowing them to lend the United States the necessary resources to fund its profligacy. Do they not realize (or care) that interest on the national debt accounts for a significant chunk of current and future budgets, and that it will only increase as interest rates rise? And that is what happens when you chase away the supply of credit by taxing it.

The bottom line is that the authors see trade as a zero sum game, where exports are Team USA’s points, imports are the foreigners’ points, the trade account is the scoreboard, and since it shows a deficit, the United States is losing at trade – and it’s losing because foreigners are cheating. A trade surplus is not the purpose of trade and trade measures are not legitimate objectives of policy. Economic growth and investment are the objectives of economic policy, both of which have thrived over the years contemporaneously with trade deficits.

Hopefully, this post offers readers a broader and more accurate perspective on these issues that are so easily and frequently demagogued.

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First assertions and statements that everyone knows mean nothing to me. Second correlation does not mean causality. Trade deficit that comes back as treasuries makes no jobs. Manufacturing is what we need and our demand makes jobs overseas. Solution is to demand equlivant trade or apply tariffs. Manufacturing jobs are created in the us. Simple!

“Do they not realize (or care) that interest on the national debt accounts for a significant chunk of current and future budgets, and that it will only increase as interest rates rise?”

Buying more than one sells the rest of the world for 37 years straight results in debt; $1.2 trillion in the last 2 years alone. Combine that with the devastation caused by manufacturing wealth loss, and voila, third world level debt and wealth disparity!

Did someone pay you to write this? No one would feign such extraordinary obtuseness for free.

Yes, a lot of the investment is in Treasuries, mainly, to keep the dollar high so they can export more to us and further monopolize manufacturing. Unlike so many MBA’s such yourself, they understand the importance of growing and sustaining their middle classes.

Imports are national savings and exports are national costs…End of Discussion. But wait…Imports are a benefit, exports are a cost. Is it clear now?

“The old mercantilists viewed trade as a way of favoring exports; the goal of international trade policy was to produce surpluses, and trade deficits were to be avoided. This view is wrong, but its continuing appeal is a testament to how difficult it seems to be to explain the basic elements of international trade theory.

It hasn’t helped that the arguments used to support the move to freer trade are invariably based on showing how exports would increase; Martin Wolf once referred to the GATT as “a disarmament treaty for mercantilists”. And that is how the Conservatives are selling trade agreements.

The real benefit to international trade is the opportunity to obtain goods more cheaply than by producing them domestically. The proper way to view exports is as a cost: in an ideal world, foreigners would provide us with an infinite amount of imports for free.

One reason why the TTP is taking so long is that one implication – foreign competition in government procurement – is being treated as a cost, when of course the possibility that taxpayers might obtain more for less should be treated as a benefit.

Trade policy would be much more sensible if our governments stopped confusing what the costs and benefits of international trade really are.”

Source:STEPHEN GORDON Special to The Globe and Mail Published Thursday, Mar. 31 2011

You wrote, “Do they not realize (or care) that interest on the national debt accounts for a significant chunk of current and future budgets, and that it will only increase as interest rates rise? And that is what happens when you chase away the supply of credit by taxing it.”

And why does a monetarily sovereign government need credit to fund its expenditures? You seem to be stuck in gold standard rubrics.

I see. So, can you explain how Germany, Japan, Sweden, Norway, Switzerland, South Korea and Holland can have universal health care, higher life expectancies, higher college attendance, lower infant mortality, better savings rates, less obesity, longer vacations, more world travel, etc, without debt to Communist China’s government owned banks? Do you think it has something to do with their huge account surpluses relative to The USA, which has the highest debt of 102 countries, as measured by The CIA?

Let me explain to you how the world economy works. The petrodollar system requires oil poor countries to obtain dollars to buy OPEC oil. It actually stimulates mercantilism among our trade partners. Conversely, The Federal Reserve/petrodollar system actually requires The USA to IMPORT to keep the dollar from inflating.

Unfortunately, not only is this reliance on debt over real manufacturing wealth creation dangerously increasing wealth disparity here, but it is rapidly eroding our national security. We are losing or have lost the ability to do heavy engineering projects, or even make ball bearings, without the aid of government owned manufacturers in China.

Mercantilism is NOT dead. International trade is just as nasty as it ever was. Understand that Iraq, Venezuela, and Iran are the 3 major OPEC members that have partially stopped, or threatened to stop trading oil in dollars and you understand the pernicious nature of the status quo.

I just wonder how we will defend the petrodollar without ball bearings or machine tools.

“Saddam switched to the euro on November 6th, 2000. The exchange of the Iraqi dollar reserves soon followed. It created an overflow on the exchange market and the dollar started its descent. (See graphic.) Considerable numbers of international traders and investors reacted by switching away from the dollar. Central banks would sooner or later have to exchange a part of their dollar reserves, too. By the end of 2002 the dollar had lost 18 percent. ”

While I don’t believe that we should cripple imports, I do believe that US manufacturers and producers should be working as hard as they can to beat the imports on price and quality. There are several things that we import in large quantity that are fundamental to our economy, but the US industries that produce those things are suffering. While your economic arguments may be correct on the short term, large scale importing has been going on for so long that you really cannot successfully argue that you know that minimizing imports by US manufacturers being more competitive in quality and price would not produce huge economic benefits. Moreover, the more that we import, particularly from nations like China or others in the far east or from oil producing countries, the less secure that we are as a nation. For the most part these countries really do not like us. They just like our money. Now, I will totally agree that no solution should include government spending. John Maynard Keynes was an intelligent idiot. And so are his many disciples. Our Founding Fathers would wretch upon seeing all the things the federal government is doing and the money that it is spending. Anyone who reads the Constitution and takes it literally (It says what it says and does not say what it does not say.) will come to the conclusion that, notwithstanding the opinions of politicians and the Supreme Court, most everything the federal government does in every arena is beyond what the Constitution allows. Government exceeding its authority always drives up the cost of doing business and makes us less competitive and makes our products be of lower quality and therefore puts us in the position of importing more and exporting less.

Think I’m wrong? Check out the Chinese steel industry. The Chinese produce almost 50% of the steel in the world and the US produces less than 6%. That is preposterous. The US ought to be the world’s powerhouse steel producer, but it will take quite a few years with a lot less government involvement and environmentalist interference to get the US steel industry in the position of being the #1 steel producer.

Just a short time ago, the US auto industry nearly collapsed totally. While there were many reasons the US auto industry got in that position, many of which were well within their control, the fact is that too much of the cars made by US based manufacturers is imported and there are far too many foreign based manufacturers with plants now located in the US. Again, the only solution is for the US manufacturers to build higher quality and lower price cars here in the US using US made parts.

The consumer electronics industry has been given over to foreign manufacturers for a long time and even the US based manufacturers of computers and phones purchase much of their parts and have much of their assembly done overseas. That didn’t happen by accident. US manufacturers could not compete on price and we did not compete on quality in many cases. Again, we need dig in and redevelop our consumer electronics industry on quality and price.

I just think that it is foolish for us to become so dependent on foreign sources for the goods that we need and use every day. Consider the UK. It was way down this road of importing too many things at the beginning of World War II. When the war came, a substantial part of their suffering as a nation came from no longer being able to import the necessities of everyday life. At that time, the US was not nearly so foolish, so, even with rationing, we did have most things for every day life, albeit in limited quantity. We were certainly way better off than the British.

Let’s just get our heads on straight and realize that, as a nation, we are the best nation in the world to live in, even today. That’s because, in character, we think and live differently from every other nation in the world. Our ancestors understood and abandoned the defective European thinking of their day, which is even worse today, and our Founding Fathers created the greatest nation that ever has been and probably ever will be. Today, we need to follow their thinking and the principles that they established.

“Government exceeding its authority always drives up the cost of doing business and makes us less competitive and makes our products be of lower quality and therefore puts us in the position of importing more and exporting less.

Think I’m wrong? Check out the Chinese steel industry. The Chinese produce almost 50% of the steel in the world and the US produces less than 6%.”

I KNOW you are wrong. IN Brazil, China, South Korea, much or all of the steel is state owned. So much for your “big government” rant. Here’s what’s kicking our as* on trade:

This article is the worst kind of sophistry, the traitorous kind that tells Americans “this is great” as we offshore our manufacturing capacity, employment and tax base. Offshoring our productive economy is national suicide, and the spreading poverty and unemployment all around us in a downward spiral are the real cost of cheap imports. Only Wall Street and the executives of the globalized corporations with zero loyalty to the USA would see the historic dismantling of American manufacturing as a good thing. Unfortunately those are the very same interests that have bought Washington DC.

Perhaps you can enlighten us, Will, as to why my position, which advocates against government impediments to trade and investment, is more anti-American than your position, which implies that businesses and jobs are entitled to exist in the United States, by dint of their being “American,” even if the verdict of the market is that they don’t provide value and even if enforcing that through government dictum impedes on everyone else’s economic liberty. The more decisions that are pushed into the political sphere, the more productive resources will be diverted to politics and lobbying. That makes all of us poorer. Instead of whining and name-calling, make a cogent argument for why protectionism and restrictions on investment are morally proper and likely to be sustainable.